When a financial advisor provides a list of investment options, you expect to see the usual suspects: IRAs, 401(k)s, mutual funds, stocks bonds. Maybe they’ll go wild and throw gold in there. A particularly young one might tell you bitcoins.
But what about alternative investment options? Something off the wall...or that hangs on a wall…
What about investing in art?
The art world touts big returns on sales, but research shows that while art should be bought for its aesthetic pleasure, it’s not the best option to fund a retirement.
The art market is booming
Make no mistake: Lots of people think they should be investing in art, and they are.
Art sales in 2014 passed $60 billion, up two-thirds over 2009 sales. Seventy-five percent of collectors and buyers "are purchasing art for collecting purposes but with an investment view." There are a number of art fairs and funds available to would-be investors.
In fact, art investing has grown so huge that it’s reached a coveted status in Silicon Valley: it’s about to be disrupted.
Arthena is an art investment startup that uses "pre-existing market data and proprietary analytics…[and] machine-learning algorithms to discover opportunities, and track the performance of your fund." It’s opening up equity crowdfunding to a wider audience, coming out of Y Combinator to "help investors make money reliably from art" by "[doubling] double the art market’s standard annual return of 10 percent."
A 20% return on investment is nothing to sneeze at. It also might be based on unreliable data.
Research says ROI on art is a bust
According to researchers at Stanford, the index of fine art sales, the standard used by art advisors to sell funds, shows an average annual rate of return of 10%. But digging deeper into numbers, that number comes out closer to 6.5% over the past 40 years. Another study found that the average return on "investment-grade art" held for five to 10 years was around four percent.
Using the Sharpe Ratio – a measure of return adjusted for risk – researchers found that art had a Sharpe Ratio of 0.04, compared to 0.30 for U.S. equities.
Why the discrepancy? Most numbers are based on auction prices, but only an estimated 0.5% of paintings are ever resold. That skews the numbers heavily, and the 10% ROI narrative – and any spinoff stories, like the one told by Arthena – may be equally as unreliable.
Art investment doesn’t offer advantages over other investments
On its own, art might not seem like a terrible investment. But nothing exists in a vacuum. Compared to other options, art doesn’t have any advantages.
As discussed, the purported ROI on art is misleadingly low. Considering how expensive art can be (even Arthena, which is bringing art investment to the wider world via technology, generally requires an initial commitment of $10,000) you can make smaller investments at a higher return elsewhere.
There are also tax implications of art investment that are rarely taken into account. Besides contributing to one’s estate, the IRS classifies art as a collectible, resulting in up to a 28% tax rate on any gains. That’s considerably larger than the 20% long term capital gains tax you’d pay on other investments like stocks.
Finally, art is difficult to move. It’s illiquid and the best way to move it – via an art auction house – can impose fees of up to 50% of the sale price.
On the other hand, art is more aesthetically pleasing than a U.S. bond, so it has that going for it.
The advice on art investment is mixed
Even if one were to invest in art, the conventional wisdom on how to do so is mixed at best.
Take art critic Brian Sewell, for example. While he says that "No one should buy works of art for investment," if you do invest in art, "Buy what everyone else is buying. It is an entirely false market and one day it will implode, but at the moment it is fiercely profitable." That makes sense: buy what people want, so you can turn around and make money off of them.
But how does that gel with Bloomberg Businessweek’s advice? "Buy out of style...obscure but important...outside the narrative" art. So...buy what no one else is buying.
The advice is so contradictory because art is notoriously difficult to assess. Careers flame out as soon as they begin, and even popular artists may only have a few hit paintings. You’re more likely to end up purchasing a bust, investment-wise, than a unicorn.
No matter how you slice it, art isn’t a smart investment for the average person – or even above-average earners. A panel discussion at UBS on art investment ended with the conclusions that "even high-net-worth individuals shouldn't have more than a 10% allocation to art in their portfolios unless they have enough income or other liquid assets to comfortably support themselves otherwise." The art world is incredibly opaque and unpredictable; it doesn’t make sense to hang your financial future on a canvas.
Does that mean no one should buy art? Of course not. Art has other purposes besides replacing an IRA. If you want to spend money on painting because you value it or the artist, you could and should. But looking to turn it around for a quick buck isn’t wise. You’ll likely be stuck with it, so you might as well buy something you’ll enjoy looking at.